On August 26, 2020, the Securities and Exchange Commission (SEC) adopted amendments that expand the definition of "accredited investor" to allow additional categories of individuals and entities to invest in private offerings that qualify for the Regulation D exemption from the SEC's registration requirements. The amendments (which are included at the end of SEC's final rule release) will become eﬀective 60 days after publication in the Federal Register, with likely effectiveness in November 2020.
The new categories of accredited investors were based primarily on investors' level of financial sophistication, deviating from the SEC's historic focus on the level of investors' wealth and income. According to the SEC's press release, "the amendments update and improve the deﬁnition to more eﬀectively identify institutional and individual investors that have the knowledge and expertise to participate in those markets."
Amendments to Regulation D: Expanded Definition of "Accredited Investor"
New Categories – Individuals. The amendments add two new categories in the accredited investor definition for individuals:
- A category that allows individuals to qualify as accredited investors who hold a Series 7, 65, or 82 license in good standing, or hold other certifications, designations, and credentials in good standing that the may be designated by future SEC order; and
- A category that enables "knowledgeable employees," as defined in Rule 3c-5(a)(4) under the Investment Company Act, of a private fund to qualify as accredited investors for investments in the fund.
The accredited investor standard for individuals had previously remained largely unchanged since it was ﬁrst adopted in 1982, requiring an individual to have a net worth in excess of $1 million or annual income in excess of $200,000 or a joint annual income with one's spouse in excess of $300,000. Those minimum thresholds were left unchanged by the amendments and were not adjusted for inflation going forward, likely meaning that more people will enter that category over time.
When determining income and net worth for purposes of qualifying as accredited investors, the amendments permit natural persons to include joint income and joint net worth from "spousal equivalents," which the SEC defines as a cohabitant occupying a relationship generally equivalent to that of a spouse. The amendments also clarify that assets do not have to be held jointly to be included in the calculation of net worth, and that the securities being purchased by an individual investor relying on the joint-net-worth test need not be purchased in joint names.
New Categories – Institutional Investors. For institutional investors, the amendments add the following entity types to the current list of entities that may qualify as accredited investors:
- Investment advisers registered under Section 203 of the Investment Advisers Act of 1940 (the "Advisers Act") or the laws of the various states, as well as exempt reporting advisers under Sections 203(m) or (l) of the Advisers Act;
- Rural business investment companies ("RBICs"), as defined in Section 384A of the Consolidated Farm and Rural Development Act;
- Limited liability companies that have total assets in excess of $5 million and were not formed for the specific purpose of acquiring the securities offered (which codifies a long-standing SEC position);
- Any entity, including Native American tribes, labor unions, government bodies and funds, and entities organized under the laws of a foreign country, owning "investments," as defined in Rule 2a51-1(b) under the Investment Company Act, in excess of $5 million and that was not formed for the specific purpose of investing in the securities offered; and
- "Family offices" with at least $5 million in assets under management and their "family clients," as each term is defined under the Advisers Act, if such family office is not formed for the specific purpose of acquiring the securities offered and its prospective investment is directed by a person who has such knowledge and experience in financial and business matters that such family office is capable of evaluating the merits and risks of the prospective investment.
The SEC also adopted conforming amendments to "test-the-water" provisions of Rule 163B under the Securities Act and to Rule 15g-1 under the Exchange Act.
Amendments to Rule 144A: Expanded Definition of Qualified Institutional Buyer (QIB)
In addition to amending the accredited investor definition, the SEC amended Rule 144A to (1) expand the definition of QIB in Rule 144A to include limited liability companies and RBICs if they meet the $100 million threshold for securities owned and invested in the definition, and (2) add to the list any institutional investors included in the accredited investor definition that are not otherwise enumerated in the definition of QIB, provided they satisfy the $100 million threshold.
Controversy in Commissioner Vote
The amendments were adopted by a divided SEC in a 3-2 vote of the commissioners, with commissioners filling Republican seats voting in favor. The commissioners filling Democratic seats opposed the amendment, primarily based on the decision not to increase the minimum net worth or annual income thresholds for individuals or to index them for inflation. In the SEC's press release, SEC Chairman Jay Clayton lauded the amendments, stating that:
"[f]or the first time, individuals will be permitted to participate in our private capital markets not only based on their income or net worth, but also based on established, clear measures of financial sophistication. I am also pleased that we have expanded and updated the list of entities, including tribal governments and other organizations, that may qualify to participate in certain private offerings."
In a joint statement critical of the amendments, Commissioners Allison Herren Lee and Caroline Crenshaw referred to the accredited investor definition as "the single most important investor protection in the private market" and faulted the SEC for continuing a "steady expansion of the private market, affording issuers of unregistered securities access to more and more investors without due regard for the risks they face, and without sufficient data or analysis to ensure that our policy choices are grounded in fact rather than supposition."
Next Steps for Companies Raising Capital and Their Advisors
Now is the time for companies raising capital in Regulation D private placements, both private and public, and their investment bankers and advisors to update their documents and processes in light of the new accredited investor standards, including revising standard forms of subscription agreements that include "check-the-box" investor representations which list categories of accredited investors.
We Can Help
If you have questions regarding the expanded accredited investor definition or need assistance in determining how the expanded definition affects your business, please contact an attorney in Maslon's Corporate & Securities Group. We are ready to help you with these changes.